What is Market Cannibalization?
Cannibalization is when a firm whose product lacks an established market occupies a share of the market by undercutting its competitors. Market cannibalization has driven many firms to turn to mergers and acquisitions in order to survive.
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Hire An Expert Tutor NowWhat is the Cannibalization Rate?
Cannibalization rate is the percentage of a product’s sales that represents lost revenue from customers buying replacement units of the same or different products from the same firm instead of those it was intending to purchase.
Causes of Cannibalization
If you are familiar with the general accepted accounting principles you are aware that competition must happen in the business world. Cannibalization is a typical thing in the business world and it encourages companies to be more creative in order to deliver more quality products to their clients. The following are the common causes of cannibalization:
1. Developing comparable goods
One of the causes of cannibalization is developing a product that is very similar to an already existing one. For example, let us say that a company plans to launch a new type of toothpaste. The company can develop one that is almost the same as another company’s product. However, the new product lacks a strong market presence and thus does not have much potential revenue.
2. Introducing new services
Another common cause for cannibalization involves introducing new services in an industry. For example, a firm may attempt to provide additional services to existing users of a product or service. It is important to avoid this because it will lead to loss of revenues.
3. Missing Out on Potential Customers
Market cannibalism also occurs when a firm misses out on potential customers who may have purchased its product. It can happen if the firm has not marketed its product properly and potential customers are not aware of it.
4. Change in Consumer Preferences
A change in consumer preferences can also be a major cause of market cannibalization. For example, a new fashion trend may completely change the way people want to look or feel, drastically shifting the market away from one type of product or service to another.
5. New Entrants in the Industry
A new entrant may enter an industry that was previously dominated by one particular firm. For example, let us say that a frozen yogurt company enters the market and becomes number one, stealing a lot of customers away from the existing frozen yogurt sellers.
Methods to Prevent Cannibalization Effect
There are various methods that when followed will help prevent cannibalization effect ethically. The methods include:
1. Determine the particular markets for each product
A firm should determine the particular market for each product, which will help them know whether or not there is a cannibalization problem. For example, if a company’s frozen yogurt is sold in several local stores, it should first determine which stores are the most profitable. The firm can then work on increasing sales in these stores to increase market share.
2. Market research
Market research that helps to ensure that the markets for their products share commonalities helps firms develop cost-effective strategies to prevent cannibalization. For example, firms should develop a strategy that suits the particular business sector they are in.
3. Cross-selling
Cross-selling is a method of increasing revenue through selling related products profitably. For example, Merck has been successful in cross-selling because customers who have purchased its anti-depression medication have also purchased other products such as shampoo and rash cream for their children.
4. Developing new products
Firms can develop new products to prevent cannibalization. For example, a firm that sells toothpaste and toothbrush will always have ongoing market cannibalization problems because other companies are selling almost the same product. To avoid this, firms can develop a new product such as an artificial toothbrush or even a mouthwash that is stronger than the one it currently sells.
5. Developing a new brand
If the market cannibalization problem is too severe, firms can develop a new brand and launch it to gain new customers. For example, if there is strong market competition between two frozen yogurt makers, the firm can develop a new brand that offers frozen yogurt with less sugar but maintains the same quality. The firm will then gain more customers than before and it will not be affected by the competition.
How to Calculate Cannibalization Rate
Every person in the accounting field should know how to calculate the cannibalization rate.
Cannibalization Rate is calculated by dividing the new product sales that replace existing sales by total new product sales.
Cannibalization Rate = Total Loss in Existing Product Sales / Total New Product Sales
Example
Best Lady company sells a skin care product (Y) for $12 and launches a new skin product (Z) that goes for $18. The company sells 60 Z and the cannibalization rate is 40%. This figure means that 40% of the new product sales are boosted because of the existing product Y. Using the cannibalization rate we can calculate the sales loss of the existing product.
40% of 60 Z=24
The value means that the sales of product y decreased by 24 from its current sales. Before the launching of the new skin product the company sold 90 samples of skin product Y. Therefore the sales of Y after launching z are;
90-60=30Y
Sales of Y after cannibalization is=30Y
Sales of new product=60 Z
(30 units x $12) + (60 units x $18) = $360 + $1080= $1440
Therefore if Best Lady had not introduced skin care products Z the total sales would be 90Y x $12= $1080. Therefore despite the cannibalization rate of 40% the new skin product brought a profit of $360. This means that the cannibalization rate did not have a negative effect on the company.
What is Break-Even Cannibalization Rate?
Break-even is a critical measure of a break-even point. It is used to determine if a product will show a profit. A product shows a profit when it breaks even.
Cannibalization Rate = 100 x (Lost sales on old product) / (Sales of new product)
A cannibalization rate is when a company’s sales of an existing product decrease after bringing out a new product.
Cannibalization is a natural phenomenon that occurs in every industry. However, it can be a good thing to the consumer. A firm can cross-sell products that increase sales. If not, then firms can either introduce new brands or products into the market to prevent cannibalization.
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More Resources
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